Start a small fund commitment vs solo-search and raise funds once under LOI

January 25, 2023

by a searcher from University of Utah in Salt Lake City, UT, USA

I am in my search and would like to discuss with someone in regards to these two options.

#1 Raise a $2-10M in a micro-fund get 10% of the fund committed upfront then once the deal is found call the rest of the capital to purchase the deal (and call capital for potential additional deals / add-ons later on).
-What are the costs to get this created? Legal fees etc? Do you just need to write up a PPM to get this going?

#2 Just start creating a list of interested investors, keep them updated as I am searching for deals and once a deal is under LOI raise the money before closing.
-What are the costs of this legal fees etc?

In either case and depending on the deal size I would put in 5-30% of the capital into the deal to show investors I have "skin in the game".

My thoughts on

#1 I think it might sound better to sellers/brokers if I do #1 because that shows I have committed capital and would feel more confident going into LOI that I have the funds needed to purchase the deal. It also locks in investors somewhat to funding my deal. Are the costs of creating a fund higher than doing #2. It also helps me to keep on rolling and buy additional businesses because I could view how much capital is pledged. It helps with know what deal sizes I can and cannot take on.

#2 On the other hand it might stress me out a bit if I have capital committed but it takes a while to find a deal, But it is only 10% of their commitment upfront. The legal costs might be larger.

Does anyone have knowledge in these two options and could provide direction for me?
Does anyone have any referrals for attorneys who are well versed in doing either of these options that I could discuss with them and get quotes and their timelines for creating the legal docs?

Reply by a professional
from Villanova University in West Chester, PA, USA

Hi Sean! Great question. Most of my clients go for option #2 for a few reasons (i) your PPM will legally need to include deal specific information (or at least industry specific information), (ii) most investors want to know what they're investing in and (iii) you can have a letter of interest signed by the potential investors to show credibility to brokers and lenders and provide you with more comfort. The costs would most likely be higher for #1 because you would need to repeat certain steps in the process. Clients who are positioned for going with path #1 are usually established funds with an investment prospectus outlining the types of deals, markets, timelines, etc. that the investors approve the fund to invest in on their behalf. Investors feel comfortable given the established parameters of the investment and the fund's track record.

With respect to legal costs for a fund and acquisition, they vary greatly depending on (i) sophistication of the investors (if they're not accredited investors, there are additional compliance requirements), (ii) components of the deal (i.e. including employment agreements, assumption of contracts or debt, real estate, third party approvals, etc.), (iii) complexity of the deal (mostly driven by compliance requirements, number of investors, amounts of blue sky law and SEC filings required based on where you're fundraising and with whom, complexity of deal terms, etc.) and (iv) cooperation of the parties (challenging parties can drag out the timeline of a deal or require extensive negotiations that otherwise might not be required).

I would be happy to have a call to discuss the particulars so that I can provide a more specific range of cost based on any additional information you have. I'll shoot you a DM.

Reply by a searcher
from Anderson University in Canton, OH, USA

I closed an acquisition last year essentially using your model #2. My search was geographically focused, so I looked at a wide variety of companies and a variety of deal sizes. I found it useful to wait until I had a specific deal under LOI because then I was able to get investors aligned to a specific deal with a specific structure. Regarding the need to demonstrate an ability to close to sellers, I sought to combat this in 2 main ways. First, I made sure everything I did was professional (website, communications, etc.), which set me above a surprising number of interested buyers in my space. Second, I had a group of "lead investors" who also served as advisors to my search. This group had impressive resumes, and they let me share their names with potential sellers, which helped build the impression that I could close a deal. In the end, no one was fully committed until closing, which was stressful, but it worked out in the end.

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